Acquiring Pharmaceutical Industry Assets in the UK: 1 + 1 = 1?

As things currently stand, both Pfizer and AstraZeneca have similarities: total sales in both have declined by about a quarter (24 and 23 % for Pfizer and AstraZeneca respectively) since 2010 (Table 1) [1, 2]; R&D budgets have also suffered as a result, showing a declining trend; but profits have been resilient in both cases. The two firms also have differences; among them an important difference is that, relative to its size, AstraZeneca has a more promising R&D pipeline than Pfizer with several molecules in late stage development—particularly in oncology—and more drugs at registration phase (Table 2) [1, 2]. If a promising R&D pipeline is a signal towards future market strength and sustainable profitability over the long term, then AstraZeneca is certainly a good bargain for the American conglomerate.

In light of the above, what can one expect from this deal? Again, history offers interesting insights. First, the key driving force for this acquisition appears to be improvements in company performance and shareholder value, mainly through economies of scale, removal of duplication in R&D, cost optimisation or reduction, increased tax efficiency and leveraging synergies, potentially leading to higher sales and greater market shares in the global pharmaceutical marketplace. However, evidence suggests that, for large companies, acquisitions in the pharmaceutical industry lead predominantly to an output decline of new molecular entities (NME) and, for mergers and acquisitions (M&A) overall there does not appear to be a net effect on productivity [3], in other words value is neither created nor destroyed [4]. Second, employment is likely to decline and R&D spend could also suffer as a result. After acquiring Wyeth in 2009, Pfizer reduced its total workforce at the end of 2013 by 36 % to a total of about 77,700 [1]. This was accompanied by a 41 % reduction in overall R&D spend: from a combined spending of $11.3 billion at the end of 2008 before the acquisition, to $6.7 billion at the end of 2013. Declining R&D spend is not always the case post-M&A, but Pfizer’s direction of travel seems to be going in the same direction: following its three largest acquisitions (Warner-Lambert, Pharmacia, and Wyeth), numerous R&D sites were shut down and the decrease in R&D spend could explain the reduced output observed post-M&A. In the case of Pharmacia, the Swedish Prime Minister referred to his country’s “negative experience” when Pfizer failed to honour its commitments following Pharmacia’s takeover [5], although much of that could be attributed to failure to bring new products to market.

The acquisition of AstraZeneca will ensure the sustainability of Pfizer’s current business model, including a greater portfolio diversification in areas where Pfizer’s strength is currently limited, e.g. in oncology. But there is much in Pfizer’s takeover proposal pointing to a knave-like behaviour. For one, history is not on its side: the closure of the R&D plant in Sandwich in the UK 3 years ago is still a fresh—and for many, painful—memory. This took place at the time when UK health and industrial policy for the pharmaceutical sector was ambivalent about the future of the Pharmaceutical Price Regulation Scheme (PPRS), predicting its abolition over the mid- to long-term.

Beyond operational efficiency and the long term sustainability of Pfizer’s business model, two additional arguments make a deal attractive for Pfizer: first, tax optimisation and efficiency and, second, the additional financial incentives provided by the new PPRS.

It is unsurprising that achieving greater efficiency in managing its tax obligations, through tax or corporate inversion, must have been a key consideration in Pfizer’s pursuits to acquire assets outside the United States, where it is tax-resident. For sure, Pfizer has accumulated significant reserves from its international business over the past 5 years, which, if re-patriated to the US, will be taxed at the going rate (35 %). A likely acquisition of AstraZeneca could signal the movement of Pfizer’s headquarters to the UK, where the corporate tax rate is significantly lower than the one the company faces in the US. Additionally, the US tax code, perhaps uniquely among developed nations, seeks to impose income tax on profits earned abroad by American corporations. Companies with strong international orientation, such as Pfizer, have a strong incentive to re-classify themselves as ‘foreign’ in order to avoid the burden of double taxation and return some of the profits to their investors. One can hardly blame Pfizer for this inconsistency in the US tax code. In fact, several other companies have strived to do the same in recent months or years, for example, Medtronic (acquiring Ireland-based Covidien) and Abbvie (acquiring UK-based Shire) and the only way for the practice to stop would be to either reform the US tax code or altogether disallow tax inversions. A favourable reform of the US tax code appears unlikely as the US authorities continue to push for legislation that could retroactively strip the tax advantages achieved by companies in some of the 2014 deals [6]. In the meantime, no direct pecuniary benefit to the UK economy is likely to emerge from a likely deal with AstraZeneca, although shareholders (in the UK and elsewhere) and large (mostly private and some public) institutional investors will realise a short-term benefit equal to the difference in the share price, discounting AstraZeneca’s portfolio and future launches.

In a likely future takeover proposal, investors will demand a leaner organization post-takeover in order to retain and possibly enhance profitability and sustain this for a few more years until new products emerge to replenish an ageing product portfolio. Whereas human capital might suffer for the sake of improving operational efficiency, physical capital might not, at least in the short term. The new PPRS, which became operational on January 1st, 2014, allows a 21 % rate of return on capital employed (ROCE) on sales to the UK NHS. Scheme members will be able to retain profits of up to 150 % of this target and may even be able to apply for price increases if they forecast profits less than 50 % of this target [7]. As a result, a combined company with a broader physical capital base may be able to make more flexible use of capital, as per the current PPRS arrangements, allowing an additional tax optimization up to a point. But a rationalization of sales forces and, potentially, R&D activities is also a strong possibility, implying losses in different parts of the world. It is highly unlikely that the UK R&D operations will escape unscathed as both companies have research facilities in the Cambridge area.

Despite the obvious tax advantages for Pfizer and the incentives provided by the UK institutional framework, becoming part of a corporate global empire could have negative implications for creativity and entrepreneurship. While scale effects are usually a key driver of corporate M&A, it is doubtful that the same argument holds in research activities, where individuality and small team spirit often drive innovation and discovery. This gives credence to the ‘small is beautiful’ argument [8] as opposed to ‘big is better’. Consequently, it is not necessarily the case that merging the activities of two large pharmaceutical manufacturers such as Pfizer and AstraZeneca will create additional value and greater impact further down the line.

Whereas it is obvious why AstraZeneca may be a good bargain for Pfizer, it is unclear how the UK economy and its science base may benefit and what the implications are for overall industrial policy. When listening to Pfizer’s CEO before the House of Commons Business, Innovation and Skills (BIS) Select Committee, one cannot help but share MPs’ worries. For sure, Pfizer cannot promise much about its UK presence over the long-term unless some specific targets are put forward and discussed upfront in order to create a win-win scenario for all stakeholders. Such targets could embrace new products, new research lines of investigation based on research priorities and, potentially, new markets.